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Why the bailout isn’t (that) bad for libertarianism

In this post, I’ll defend a thesis that my libertarian friends will probably disagree strongly with — that the economic panic culminating in the $700 billion bailout isn’t all that bad for capitalist and libertarian ideals in the long run.

Don’t get me wrong. The bailout is a monstrosity, a tremendous allocation of power to competent but unaccountable (and unelected) officials like Paulson and Bernanke and will add an unbelievable $2500 per person to the national debt. It will tax the many and reward the few. It will use the power of the state to reward businesses that ought to fail and will nationalise a significant chunk of the banking sector. As a measure, the whole thing is as unlibertarian as it gets.

But my point is this: it could have been worse. Under the current circumstances, the bailout might be one of the better things that may have happened. Here’s why:

1. Capitalism, especially of the kind that we have currently, invariably produces booms and busts. Some businesses will fail and others will grow. In the long run, it is one of the best concepts man has ever come up with. Unfortunately, voters are more impatient than that. It is a fact that with the economic turmoil of the last week and with the housing market yet to bottom out, a diving stock market would bleaken the economic outlook of the country to the extent that a new administration, likely a democratic one, would be emboldened to enact far worse regulation that the bailout itself. Think of a socialistic counterpart of ‘disaster capitalism’. The bailout will reduce the chances of that happening.

2. Yes, there were other ways the government could have intervened instead of buying bad assets, such as partial debt forgiveness or infusion of capital. However the proposed prescription has the advantage of creating a strong backlash from the electorate about their tax money being used directly to rescue the fat cats of Wall Street. There is some evidence that this is already happening. In the long run, this sentiment may develop into a general mood against government intervention and corporate subsidy. And that would be a really good thing.

3. There have been many comparisons made between the present bail-out and the massive government intervention almost eighty years ago which ended up prolonging the Great Depression. However, such comparisons miss a crucial point. The fall of the money supply that happened then under the aegis of the Federal Reserve will not happen today. As Bernanke himself said in 2002, “Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”

4. The plan is a vague one. It is not clear that Paulson actually intends to spend the entire $700 billion, nor is it clear how the government will price these bad assets. The liberal economist Paul Krugman suspects that the whole thing “looks like an attempt to restore confidence in the financial system” rather than go to the root of the problem. From a libertarian perspective, this is not such a bad thing. Remember that Paulson and Bernanke, the architects of the bailout, are no socialists. I am hopeful that their vision of the plan centers not around massive spending but in giving investors enough confidence and the banks enough time so that they can recover. (As Paulson himself has remarked in the past, “If you’ve got a bazooka, and people know you’ve got it, you may not have to take it out.”) If the government does buy mortgage assets, I hope that they do so at a price that transfers a signicant burden upon those who made these bad decisions.

5. The events of the last week essentially kills the Glass Steagall Act, one of the lasting vestiges of Roosevelt’s policies. Essentially, that act separated the commercial and investment banking sectors, which was unfortunate because unified banking is now recognized to be much safer. The act was basically repealed during the Clinton era but BOA’s acquisition of Merrill last week was the final nail in the coffin. We are now back to the situation of the 1920s, when commercial banks could plunge into the market, and that’s a good thing.

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18 Responses

Only in the sense that the fall of soviet russia wasn’t (that) bad for communism. Yeah… it could have been worst but hey it could have been way better too.

This bailout is the collective refusal of th US to address a very fundamental market flaw. If you are too big to fail then you are too big to exist. You should be either broken up or regulated or insured against failure using the tax payers money and in the last case the tax payer needs to be paid for the protection being provided.

Right now, it is very difficult to see this as anything other than a massive conning of the US public. In any sane country, like say India, a situation like this would lead to a revolution and massive market reforms. Unfortunately, US is under a massive not my problem field cast using the magic staff of level 10 poor education and level 20 controlled media. I expect that hey will very soon get back to that important debate about whether a billion dollar healthcare scheme makes them commie.

ASK- A confusing comment, to say the least. In your second paragraph, you advocate strong regulation on large corporates while in the third paragraph you say that the situation would have led ‘massive market reforms’ in ‘any sane country’. Generally, market reforms mean deregulation.

Also, remember that the similar situation in India with regard to Unit Scheme 64 provoked almost exactly the same reaction from the Indian govt., namely a massive bailout. Like Bear Stearns, US 64 was considered too big to fail. There were dissenting voices but no ‘revolution’.

The plain fact is that financial markets, especially investment banking, is the one area voters know least about.

On a separate note, the US media doesn’t simply consist of a few state-towing conglomerates. Even at the height of 9/11 panic and the Iraq war, the breadth of opinions expressed in the media here was astonishingly large (that is a fact hard to appreciate when one is sitting in a diferent country and simply listening to the filtered voice of the US media from there). As for the bailout itself, you will get a sample of the media reaction by a simple Google News search. You will notice there are hardly any supporters.

I was just going to point out the Jalan-Sinha rescue of UTI’s US-64 as an example for what Bernanke-Paulson are going to do with the “bad debts” they buy from the banks for the sake of “de-clogging” the credit system. A SPV will have to be created which will have the loans on the asset side, and debts payable to the banks on the liability side. And the banks would be paid slowly as the debtors repay their mortgage or till the loans can be realized by selling them to willing buyers. This will clean up the system and at the same time prevent banks from lending more money because they would have already extinguished the artificial limit on pyramiding set by the Fed. But that is not going to happen because it would mean lending would take a huge beating – the banks assets would basically be in deep freeze till they get realized; not something that either the politicians or the banks can afford. So, the plan will necessarily mean that the banks get immediate access to anything like $700 billion-$1 trillion for their lending purposes.

The economists and bureaucrats will complicate things like hell so that people don’t understand where the hell the money is coming from and who is paying for it. But there are few options available. Unless the US government borrows money from the market by sucking away liquidity (from an already illiquid market) by issuing bonds, the bailout means –
a) printing more paper money to pay for the NPAs, and the duo will be lynched for doing that, or
b) capitalizing the SPV by borrowing from the Fed – a book entry – money being transferred from the left pocket to the right pocket, and “paying” the banks in money the government holds at the Fed.

While we talk about the tax payers’ money being on the line, the fact remains that when it comes to the Federal Reserve, tax payers become irrelevant. It can create money out of thin air and tweak the money multiplier and CRR (as the RBI calls it, don’t know what the Fed calls it) any which way it wants. So I don’t see how the tax payer will be paying for the bailout except through a further reduction in the purchasing power of the dollar, which is definitely going to happen given the inflation that is bound to follow with the increase in money supply on the same asset base.

That is my opinion on the bailout. As for its effect on “capitalism” and “libertarianism”, the crooks (Big Business) – people who cannot survive except by crushing their competition through the government – have dealt a mortal blow. I don’t think a recovery is possible, ever, because now the whole world believes that “the ‘fat cats’ are capitalists and since even the capitalist USA engages in bailouts, it shows that capitalism does not work”.

Paulson and Bernanke are no socialists – they are worse – corporatists.

What should have happened is every bank saddled with bad assets should have revalued them and written the losses off against their capital. If they went bust, so be it.

Reform equals deregulation is a free market anarchist position. That is not my position. For me sometimes reforms mean regulation and sometimes they mean deregulation.

I am all for checks and balances and playing by the rules. I am not asking for any “strong regulations” here. Just the rational checks and balances will do. If you are too big to fail you have to insure or limit your risks. Which is what anyway should have been and will surely happen once the dust begins to settle.

And I call no-fair on the UTI thing. The UTI bailout of 2001 was what some 1000 crores. The government also drew a fair amount of leverage. The UTI management was sacked and all kinds of other stuff done to it. India’s expenditure budget for that year was about 300, 000 crore. And yes, we did have a fair amount of noise about it.

The bailout here is more or less going to be in the range of half a trillion dollars. The US expenditure budget is 2.7 trillion dollars. The Indian thing was a sinking raft. This here is the titanic.

Apart from scale, if memory serves me right, the US 64 wasn’t a too big to fail case. Indian economy has lived through many scams way larger than that. It was a case of the government ending up making false promises and incentivizing a whole generation of Indians to invest their savings into it. If it would have gone down a massive amount of Indians would have lost their savings. It would cause a whole lot of suicide and bad press but nothing like a market meltdown. Or I got it all wrong which is entirely possible because that was pre-internet era and all I read came from my local newspaper which wasnt all that good.

Back to the issue at hand, I understand that you need a bailout. But you are getting a pretty shitty bailout. You are not a mixed economy like India. Your rules of the game are free market. The tax payers are paying they should get the best deal possible. Buy the assets but at fair market price. Or get some funky equity in the bargain and put up some systems in place that ensure a payback whenever these firms get healthy again. I just can’t help but feel that you guys are being massively swindled. That or my understanding of economy has some major gaps.

Yea… my last comment didn’t read that well but I hope I have managed to be more clear this time.

@aristoitle the geek

Yea… The right thing to do here would indeed have been to let those who made bad decisions go bust. That sure would have looked quite ugly though.

By the way, every penny created out of thin air is the taxpayers money, right? It is basically devaluing the wealth of every citizen thereby effectively extracting a tax from every citizen proportional to their wealth. So ya, one way or the other, it is the taxpayer who will be footing this massive bill.

Rothbard explains in his The Case Against The Fed (pdf) that inflation that is a result of increase in money supply does not reduce the purchasing power of everyone’s money in a uniform manner – Friedman’s “helicopter effect” is a distortion he says. Those who lay their hands on the money or its equivalent first, get it for free, and benefit wholesomely. Then as the money flows around the system, prices start rising as a result of more money chasing the same amount of goods, services, whatever. So the lower down the chain you are, the more you feel the pinch. That is the difference.

Hmmm…. So in a market with perfect information, we would have an instant and uniform inflation but in the real world the inflation takes quite a while to spread through the market and there are people who can benefit from closing the arbitrage. Is that what this amounts to? I would love to read that whole but that’s a 162 page pdf and unfortunately, my job doesn’t leave me that much free time. Care to point out a few relevant pages?

A great post, and a very interesting point of view. I would differ, however, since the basic premise of capitalism – and free markets – is that economic agents bear the consequences of their decisions. I agree that in this case, it is not completely black and white – however, what cannot be denied is that people and institutions have not been held accountable for their actions, and while many see some kind of bailout as the only option, the fact is that you are only encouraging what economists call ‘moral hazard’, and that is never a good thing. I agree with Aristotle – ‘every bank saddled with bad assets should have revalued them and written the losses off against their capital. If they went bust, so be it’. Finally, whether through inflation, or less money for provision of ‘government services’, the tax-payer is the one bailing out the investment bankers who played with other people’s money and earned millions in bonuses doing so!

I agree with the principle “every bank saddled with bad assets should have revalued them and written the losses off against their capital. If they went bust, so be it.” My post wasn’t a support of the bail-out, though the way I phrased it, it may have appeared to be so. I agree with almost everything QI and Aristotle have said above.

I was simply pointing out that of all the viable options available on the table, this one might end up doing less harm to capitalist principles in the long run. Let’s not confuse ‘doing the right thing’ and ‘doing the thing that would cause least harm to the right principles’. In the real world filled with imperfections and politicians, they are often not the same thing.

As for ‘moral hazard’, its a great point, and one that indeed worries me. I did take that into account when I wrote the post. I am usually wary of anything that sets a precedent (as you might notice from my frequent posts about slippery slope effects related to social issues, such as free speech or anti-discrimination laws). It is possible that I am underestimating this hazard in this case, or being overly optimistic. I suppose we will find out eventually.

Another thing that I’d like to point out though is that many people are saying this is the end of ‘capitalism’ (‘capitalism’ = capitalism as has been practised in the US and much of the world for the last hundred years, which is actually the real thing mixed with dollops of corporatism). I think they are wrong. They said the same thing during the great depression, during the crisis of the 80s, during the South East Asian crisis of the 90s and during the dot-com bust. It didn’t happen then and it will not happen now.

@ask
Arbitrage is a legitimate activity that takes advantage of price and rate differences across markets, and anyone can do that as long as he has the information at hand. But in the case of magic money, the one who conjures it up necessarily benefits because people have zero knowledge that his money is fake (if we can call it that), and this is not arbitrage. By the time people realize that demand for a whole bunch of commodities have gone up overnight, and adjust prices to prevent themselves from being robbed (selling at lower prices and then being forced to buy at higher prices later on), things are too late. This is real inflation. Even in theory, uniform inflation is only possible if everyone’s stock of money sees a uniform percentage rise. And if that is going to happen, why inflate at all?

The essay is 162 pages of big print. And most of it – particularly the history of the creation of the Fed (the second half) is skim-able. A 45-minute read, at the most. If time is an issue, I would recommend reading the first half – about 60 pages, which explains – among other things – what money really is and how banks indulge in fraud when they operate on the principle of fractional reserve banking.

Well whatever happens, one thing is certain – with this bailout, begging and thieving have now become respectful professions.

If, as seem likely, the Dow Jones keeps plumetting, I guess that a scaled down version of the bailout will be introduced again, possibly on Thursday itself. This time it will pass. The new bill will likely have less allocation of money and some other changes.

The reason I have not posted on the matter is that I am not exactly sure how I feel about this failure. On the one hand, I am happy, because a bailout of this nature is against everything I believe in. On the other hand, I am worried, partly because the economy is not looking too great and even more because of all the reasons I outlined in my original post above.

Suppose, somehow, the bailout does not pass at all in the next two months. Maybe those who voted against it today decide they have more to lose by switching later and continue steadfast. If the economy continues to suffer, we might then see government intervention on a scale far worse than the bailout itself. In the long run, that will be disastrous. Remember that for the first time in many years, it seems extremely likely that the executive as well as both houses of legislature will be controlled by the Democrats.

[Edit, later]: As I predicted above, a modified version of the bailout passed later that week.

Every company should have crashed and burned no matter what the consequence. Then Americans would see just why runaway unregulated capitalism is so dangerous. Its already turned you into the most obese nation, the worlds biggest arms exporter, the biggest polluter, and as champions of instant gratification and short termism it will not be long before Americas social fabric decays completely – now your dinosaur age car industry is also up the spout. Why? Because Americans think that 35 mpg is fuel efficient. They actually think that! Go to Europe or Japan – anything less than 60mpg is considered poor. Corporate bosses have just stuck with the status quo instead of making themselves competetive in a global market – they deserved to go down-shame about all the workers that would be shafted though – let down by their bosses who get paid 100x the salary and mess up their jobs completely. The bailout is a 100% socialist deal, there are very many sucessful and happy socialist countries. Libertarianism is just an ideology of greed. The basic fact is that power corrupts and the heads of 100s of corporate leaders should be rolling about now. I’m talking jail time – they have committed financial crimes against millions of Americans.

Ben, I sincerely hope the world is full of people like you – those who believe in socialism. And I hope the world becomes a socialist ‘paradise’ where the government determines everything, or better, a communist one – a world without private property – a world full of beggars. Because only this kind of shock treatment will make people realize the true nature of socialism – an ideology that has the blood of millions, and the sanity of a lot more, on its hands.

Since “Pure” Socialism is only a temporary resting place on the way to Communism, knowing the intentions of Marx as regards Communism – his Communist Manifesto – makes sense-

1. Abolition of property in land and application of all rents of land to public purposes.
2. A heavy progressive or graduated income tax.
3. Abolition of all rights of inheritance.
4. Confiscation of the property of all emigrants and rebels.
5. Centralisation of credit in the hands of the state, by means of a national bank with State capital and an exclusive monopoly.
6. Centralisation of the means of communication and transport in the hands of the State.
7. Extension of factories and instruments of production owned by the State; the bringing into cultivation of waste-lands, and the improvement of the soil generally in accordance with a common plan.
8. Equal liability of all to work. Establishment of industrial armies, especially for agriculture.
9. Combination of agriculture with manufacturing industries; gradual abolition of all the distinction between town and country by a more equable distribution of the populace over the country.
10. Free education for all children in public schools. Abolition of children’s factory labour in its present form. Combination of education with industrial production, &c, &c.

And the Americans are probably half way there. If only they could do away with Obama and the Democratic Party’s resistance with regard to nationalization, and kick out the last few free market zealots from the Republican Party.

If America is an example of “unregulated capitalism”, Hitler was a saint, and we don’t need such saints. What we need is a Stalin, or a Mao – misunderstood, benevolent souls. That’s why we need socialism to succeed, urgently. ‘Crash and burn’ – that’s what is needed.

I am truly sick of people shouting their rage against free market Capitalism and how it failed us. Wake up.
The only problem with our free market is the socialist programs that will not allow the free market to work. Labor unions, oppressive regulation, punitive taxation, and feel good programs like fannie and freddie, along with government officials (Barney Franks and his ilk) placing political correctness in control of our economic future.
……. I just heard President elect Obama say that “only government can fix this”. Great, it’s done a spectacular job to date.

I REALLY enjoyed your post and blog! It took me a little bit to discover your site…but I bookmarked it. Would you mind if I threw up a link back to your blog? I have a Political Humor site of my own at White Rabbit Cult. Regards!